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Exposing the Myths

An international obsession with the Chinese currency appears to be deflating.
This passion began with Japanese accusations that China's undervalued
currency was causing its deflation, continued with Europeans blaming it for
slow European Union growth, hit full power with a vast U.S. National Association
of Manufacturers' campaign blaming it for job losses, and reached its
pinnacle when Michigan's governor, Jennifer Granholm, declared she would
back a presidential candidate based solely on the issue.

Then reality set in—well, a little bit. Last month, the Japanese, who
started the whole thing, refused to back U.S. President George W. Bush's
pressure on China. On October 30, the Bush administration admitted that China
was not violating rules against currency manipulation. The Federal Reserve Bank
has, likewise, published research showing that China is not primarily responsible
for U.S. job losses. This latest round of anti-China obsession is now understood
to have been rooted in 12 myths.

Myth one: China established its fixed-rate system to undervalue its currency
in order to promote exports, thus infringing international prohibitions against
manipulating the currency in one direction to create a disguised export subsidy.
In reality, when China established its fixed-rate system in 1994, it overvalued
the currency, compared with market rates from 1994 through to early last year,
as shown by black-market rates and capital flight. From 1997 to 1999, U.S. and
other world leaders praised China for resisting market pressures to devalue.
Thus, China's fixed rate has overvalued the currency for more than seven
years, hurting exports, and undervalued it for less than two years.

Myth two: The Chinese currency is a principal cause of the loss of 2.7 million
manufacturing jobs in the U.S. As Charles Wolf, of The RAND Corporation, has
pointed out, when productivity grows faster than gross domestic product, and
during recessions, jobs decline. The difference between productivity and growth
is such a powerful cause of job losses, without Chinese influence, that there
is a mystery why more jobs have not been lost. Many assume that, as manufacturing
jobs in the U.S. decline, manufacturing jobs in China rise. In fact, rising
productivity leading to the loss of manufacturing jobs is much more powerful
in China than in the U.S. Depending on which figures one uses, the decline of
manufacturing jobs in China may be more than 10 times the American loss. All
calculations show that Chinese manufacturing job losses are proportionately
more severe than in the U.S.

Myth three: The rise of the service sector at the expense of the manufacturing
sector means that Americans are being forced out of high-paying manufacturing
jobs and into low-paying service jobs. The reality is that while some workers
lose steel jobs and move to McDonald's, the larger trend is higher-paying
service-sector jobs squeezing out lower-paid manufacturing jobs.

Myth four: Restricting imports from China would reduce U.S. unemployment. In
reality, over recent decades, more protectionist economies like France and Germany
have experienced a negligible increase in total jobs, while the more open U.S.
has experienced a huge rise in total jobs and achieved unemployment levels about
half those of France and Germany. Restricting imports would make America's
economy behave like that of France.

Myth five: America faces a manufacturing crisis, caused by competition from
China. The reality is that U.S. manufacturing production has soared, decade
after decade. Imports from China equal only 5 per cent of U.S. manufacturing.

Myth sixth: Due to its undervalued currency, China is taking over manufacturing
of almost everything. In reality, China's successes have been concentrated
in low-end manufacturing.

Where China has tried to move quickly into higher-level exports, as in Shanghai,
huge investments have resulted in slower export growth than elsewhere in China.
About 83 per cent of Chinese technology exports are the exports of foreign companies,
and the bulk of the profits typically go to those companies. China's hi-tech
imports greatly exceed its hi-tech exports.

Myth seven: If China's currency were revalued by, say, 20 per cent, there
would be a dramatic decline of its exports to the U.S. In reality, the impact
would be quite limited because most Chinese exports rely heavily on imported
parts. While international financial institutions have not completed research
on the import content of Chinese exports, their best guess is that the average
Chinese export is made up of 75 per cent imported parts. Therefore, a 20 per
cent revaluation of China's currency would result only in a trivial 5
per cent rise in export prices.

Myth eight: China runs a massive surplus, which shows its currency is undervalued.
In reality, while China runs a large trade surplus with the U.S., its global
current-account surplus is quite small and may be vanishing completely.

Myth nine: Like old Japan, China's superior growth comes from pushing
exports. In reality, in recent years, net exports have contributed negligibly,
and in some years negatively, to China's growth. Domestic housing, cars,
retail sales and infrastructure investments keep the economy booming.

Myth 10: Because of its undervalued currency, China is exporting deflation
to the world—a principal Japanese complaint. In reality, because China
kept its currency overvalued during and immediately after the Asian financial
crisis, when its competitors devalued by huge amounts (for example, Thailand
and the Philippines by 50 per cent), China experienced deflationary pressure
from abroad, worsening its problems, as it shifted 60 million people out of
state enterprises. Cheap Chinese goods could not have affected Japanese deflation
by more than 0.1 to 0.2 percentage points out of 3.5 points last year.

Myth 11: Economists agree that China's currency is overvalued. In reality,
the currency is under upward pressure as long as capital is allowed to flow
in, but Chinese are mostly prohibited from sending money out. If all controls
were freed, as foreign critics demand, some of the almost US$ 2 trillion now
deposited in insolvent Chinese banks and earning negligible interest would flow
overseas, leading to devaluation. The message to beleaguered manufacturers is:
be careful what you wish for.

Myth 12: Proposed remedies and sanctions have been carefully designed to protect
U.S. jobs. In reality, if implemented, they would mostly just shift jobs from
China to other Third World countries at the expense of U.S. consumers. Most
notably, at the top of the list of proposed remedies has been limits on surging
Chinese bra imports. This would be a triumph for Latin American lobbyists, but,
according to one of the largest U.S. sellers of bras, the US does not make bras
and, therefore, has no jobs at stake.

William Overholt holds the Asia Policy
chair at The RAND Corporation, a non-profit research organization based in California.

This commentary originally appeared in South China Morning Post on November 17, 2003. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.

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